Chapter 5: Ethical Practices and Obligations - K, L, M - Selling Away, Excessive Trading, and Outside Securities Accounts

Question 1

Selling away

Answer 1

All transactions effected by an agent must be done through the agent’s employing broker/dealer, and must be recorded in the broker/dealer’s books. When an agent effects private transactions with customers not recorded on the books of the agent’s employing broker/dealer, the agent is “selling away,” and is in violation of the USA.

Question 2

Excessive trading

Answer 2

An agent must be cautious to recommend only trades that meet a client’s stated financial objectives, and that are appropriate based on the client’s available financial resources. The frequency of the client’s trade must not generate excessive transaction fees. Causing a client to make transactions that are excessive in size or frequency based on the client’s situation is in violation of the FINRA’s conduct rules, and is prohibited. This prohibited practice is called churning. Churning is defined as excessive trading in time and or frequency for the sole purpose of generating commissions.

With regard to mutual funds, recommending that a customer move assets among different fund families without legitimate reason (in order to generate commissions) is called switching, and is considered a violation.

An alternative to switching would be to offer clients the opportunity to exchange within a common family of funds. Most fund families offer exchange privileges without any fees or charges. However, the IRS considers the switch between any mutual funds (even within the same family of funds) as a taxable event, and the appropriate capital gain and loss rules apply.

Question 3

Outside Securities Accounts

Answer 3

When an agent of a firm wants to open an account at another firm, the agent must notify both the employing firm and the executing firm before the account is opened. The employing firm must notify the agent in writing of approval or disapproval of the request.